As businesses multiply the number of their legal entities and work across several jurisdictions, tax compliance becomes a high-risk area fraught with adverse tax adjustments, fines and penalties. The challenges of tax compliance become all the more complex, with legal entities being in a state of constant flux due to M&A deals, restructuring and rationalization programs.
Today, tax compliance transcends tax departments and relies on entity management, legal teams and legal technology to mitigate risks, provide visibility and ensure a strong paper trail. Below we go into more detail about the challenges faced by tax teams in transfer pricing and how entity management software can enforce tax compliance.
Challenges Faced by Tax Teams in Multi-jurisdictional Environment
When companies create new business entities to mitigate risks, these entities get involved in a number of transactions. These transactions can include licensing of intellectual property, financing, strategic support, sales of goods and services and other operations. The group has to allocate profits among its entities and ensure tax compliance while the taxes are filed by each individual entity in its respective jurisdiction.
Determining which legal entity pays taxes on each portion of profits, known as transfer pricing, becomes one of the highest risks for multinational organizations. In many cases, tax authorities in respective countries can have opposite points of view, seeking to maximize their tax take. In such situations, when one of the countries challenges the transaction, there is a risk of double taxation.
At the same time, tax departments face an ever-changing regulatory landscape in multiple countries. All too often, tax teams have to comply with vague new tax rules without clear guidelines. Having to operate in an unclear regulatory landscape while managing so many stakeholders puts tax departments under enormous pressure, exacerbated by short timelines, heavy penalties, and regulatory action.
While substantiating the allocation of profits, the tax departments have to rely on intercompany agreements, which should reflect the relationship between the entities. When an organization has several hundreds or thousands of such intercompany agreements, it is not uncommon that these agreements do not reflect the profit split or are otherwise weak and don't match the reality of the transactions due to gaps in legal work.
How Can Tax Departments Mitigate Those Risks with Better Entity Management?
While the interpretation of tax rules is an expert enterprise, having the handle on legal entity structure and creating a paper trail of legal entities, transactions, ownership rights, and relationships is foundational for minimizing transfer pricing non-compliance. As practice shows, in case of disputes, the authorities and the tax courts pay close attention to legal entity structure and intercompany agreements, which play a critical role in substantiating the allocation of profits.
Since tax filings are subject to scrutiny by tax authorities looking for ways to increase their tax takes, any deficiencies in data or documentation will become weak points which can result in adverse tax actions and penalties. In this situation, it is mission-critical for tax teams to have a central repository of accurate data on legal entities and a database of intercompany agreements reflecting the nature of the transactions.
The traditional siloed approach, where the tax department is the only one responsible for group tax compliance, is no longer valid. With the constantly changing organizational structure, tax teams need to have clear lines of communication with the legal department and to have tax and legal aspects in alignment. In this context, having valid and legally binding agreements between legal entities reflecting the actual nature of transactions is crucial to achieve transfer pricing compliance and mitigate risks.
Meanwhile, none of these agreements can exist in a vacuum without the existence of legal entities. When legal entities are not proactively maintained, it automatically triggers transfer pricing non-compliance and other risks. Managing hundreds and thousands of legal entities requires having a single source of truth for all entity data with immediate access and functionality for sharing and updating such data in real time across the whole organization.
How Does Entity Management Software Address Tax Team's Pain Points?
Given the sheer volume of data and the number of stakeholders, the tax department needs to be assisted by technology to ensure data integrity and integrate data in various ecosystems.
It is a common understanding among tax and legal teams that siloed data can create roadblocks in the transfer pricing process. To avoid this, organizations need entity management software which would become a single source of truth for entity data. Such system would allow to access, update and use data for various purposes, also automating the production of documents.
Businesses need to digitize their minute books and have all their entity information in digital format, enabling cloud storage of their data accessible anytime from any device. These data should be up-to-date and accurate at any point of time to ensure the validity of the agreements based on corporate records.
The entity management software must ensure that if one data point changes for an entity, the same data point changes everywhere. Only when this condition is met, both the tax and legal team can be sure that there is no latent risk in the paperwork and transfer pricing arrangements.
The next important aspect of entity management for tax compliance relates to the automation of documents. When organizations manage thousands of agreements, it is essential to have the ability to automate the production of this documentation which would otherwise take a lot of internal or external resources. Meanwhile, document automation should always be based on accurate data, stored, maintained and updated in real time.
Learn More with Athennian
In a modern multijurisdictional economy, companies' tax departments need to rely on entity management software to have a handle on all their legal entities, ensure the accuracy of data in tax filings and have strong documentation to substantiate the allocation of profits across the organization. If you are interested in learning more about how entity management software can enforce tax compliance, please don't hesitate to schedule a customized demo with one of our entity management experts.